Our blog post last week discussed why the EU needs a set of harmonised Solvency II rules to more effectively supervise the EU wide insurance industry. Solvency II is a transformation event for insurers and will have a profound impact on the way insurance companies approach risk management decisions. It places greater emphasis on enterprise wide change management and readiness issues are currently top of mind in EU insurance companies.
Solvency II – what will be different?
We have highlighted below some of the key differences between new and old:
Solvency II is a risk based approach
Solvency II will introduce economic risk-based solvency requirements across all EU Member States for the first time. These new solvency requirements will be more risk-sensitive and more sophisticated than in the past, thus enabling a better coverage of the real risks run by any particular insurer.
Solvency II is more comprehensive
Solvency requirements will also be more comprehensive than in the past. Whereas at the moment the EU solvency requirements concentrate mainly on the liabilities side (i.e. insurance risks), Solvency 2 will also take account of the asset-side risks. The new regime will be a ‘total balance sheet’ type regime where all the risks and their interactions are considered.
Solvency II is more market focussed
Insurers will now be required to hold capital against market risk (i.e. fall in the value of insurers’ investments), credit risk (e.g. when third parties cannot repay their debts) and operational risk (e.g. risk of systems breaking down or malpractice). These are all risks which are currently not covered by the EU regime.
Solvency II is more balance sheet focussed
The new regime introduce more risk-sensitive solvency requirements and adopt the ‘total balance sheet’ approach to measuring solvency, the new regime also emphasises that capital is not the only way to mitigate against failures. Under Solvency II’, new rules will for the first time compel insurers specifically to focus on and devote significant resources to the identification, measurement and proactive management of risks.
Solvency II is requires more forward thinking and planning
The new solvency system will also adopt a more prospective focus. At the moment solvency requirements are based on largely historical data, the new rules will require insurers also to think about any future developments, such as new business plans or the possibility of catastrophic events which might affect their financial standing. A new development in this area will be the introduction of the “Own Risk and Solvency Assessment” (ORSA)”
Solvency II will change the way Supervisory Authorities work
Another new requirement is the “Supervisory Review Process” (SRP). The purpose of the SRP is to enable supervisors to better and earlier identify insurers which might be heading for difficulties. Under the SRP, supervisors evaluate insurers’ overall risk profile to ascertain that they hold adequate solvency capital and that their risk management and governance systems are adequate to the nature, scale and complexity of the insurer in question. The ORSA, together with a robust SRP, will introduce a new discipline to the industry that will help in ensuring the stability and long-term sustainability of the European insurance industry.
Solvency II requires more disclosure from insurers
The new Solvency II rules require insurers to disclose certain information publicly to a far greater extent than currently is the case. This will bring in ‘market discipline’, which will help to ensure the soundness and stability of insurers, as market players will be able to exercise greater supervision over and offer greater competition to other insurers. Insurers applying ‘best practice’ are more likely to be rewarded by lower financing costs, for example.
Solvency II will bring a more consistent risk based approach
Finally, the new framework will strengthen the role of the group supervisor who will have specific responsibilities to be exercised in close cooperation with the local or national supervisors. This will mean that the same economic risk-based approach will be applied to insurance groups which can now be better managed as a single economic entity. Furthermore, the new solvency provisions will foster and force greater cooperation between insurance supervisors and will further supervisory convergence.
For more information about how JMR Consulting UK Ltd can provide a safe pair of hands for your Solvency II programme, please get in touch by using the contact form, sending an email to info@jmruk.com or calling us on 0845 052 0900.
what the full effect of Solvency II will be on the European insurance landscape in general.
There is something of an inherent paradox in Solvency II when it comes to smaller firms. On the one hand the regulation aspires to harmonise the European insurance market, while on the other, it must allow the market to operate freely and without distortion. The latter means protecting diversity and allowing small firms to thrive and provide valuable localised services. Quite how a one-size-fits-all regulation can do that is unclear.